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Friday, 11 March 2016

As shipping freight rates fall; what does the future hold?

What is the
similarity between oil prices and shipping freight rates? Of course, the first
similarity is that the prices of oil and shipping freight rates have been
consistently falling for the last two years. Both oil prices and shipping
freight have another similarity. Both have been hit by a global economic
slowdown which has resulted in contraction in demand. But the most important
similarity between oil prices and shipping freight rates has been the build-up
of excess supply. Like oil companies invested heavily in shale capacity when
oil prices were at above $100/bbl, similarly shipping companies also built up
tremendous capacities during the last 3 years when the CCFI Freight Index was
quoting in the range of 1150-1200. Today the index is down to 735 and, with
more capacity coming up by the year 2019 it is doubtful how much the freight
rates can increase from here.

Consider this
simple example. Today it costs less than $300 to move a 40-foot container from
Shenzhen in China to Rotterdam in the Netherlands. This is not even sufficient
to cover the cost of fuel and handling. Even if we do not consider the
exorbitant Suez Canal fees, the entire trip is unviable to begin with. But
cargo is still moving at these cheap rates, before ships cannot afford to idle.
Remember, both oil extractors and shipping companies have taken on tremendous
debt to fund this expansion and hence they will have to continue to supply,
irrespective of low prices.

Falling Freight Index...

As the above
chart suggests, Shipping Freight Index has fallen from a high of 1150 in 2014
to as low as 735 in March 2016. For a very long time, the large shipping
companies could manage to maintain the price at profitable levels due to their
control over the shipping lines. But then, enormous shipping capacity has been
built up in the last 3 years. Shipping capacity grew from 15.4 million TEU in
2011 to 19.6 million TEU in 2015. Hence, the luxury of managing price is not
there with shipping companies any longer. The immediate mandate is to run all
ships at full capacity and focus on market share instead of pricing.

So, is it all about a global slowdown in trade?

There has
been a slowdown in trade worldwide over the last one year, including in China.
But weak trade does not tell the whole story. For example, China’s annual
imports are at $1.95 trillion and annual exports at $2.4 trillion. At a total
trade value of $4.35 trillion, China is still contributing a lot more to global
trade than it was doing 3 years ago. Ironically, the CCFI freight index was at
a high of 1200 before 3 years. Therefore, the fall in volumes does not entirely
explain the sharp fall in shipping freight rates.

It is actually about overcapacity in shipping:

We have
already seen how Global Container Ship Fleet has increased its capacity by 27%
in the last 4 years. The demand has simply refused to keep pace with this
massive overcapacity that was initiated back when the CCFI Freight Index was at
a high of 1150-1200 range. In fact, global consultancy firms like the Boston
Consulting Group (BCG) expect another 30% increase in container ship fleet
capacity by 2019 before the overall supply will plateau out.

The road ahead for container ships:

The scenario
described above is hardly a sustainable scenario. But the bottom-line is that
this situation is unlikely to change for the next couple of years till the time
supply does not plateau and demand does not pick up. Both are unlikely to
happen immediately. Broadly, there are a few key strategies that global
shipping freight companies are adopting to overcome this supply glut:

·The fist strategy has been to keep their cost of
operation at optimal levels to stem losses for the next few quarters. One
example is of container ships moving oil via the Cape of Good Hope instead of
the Suez Canal. Due to cheap crude oil prices, shipping companies can afford to
do the same. This also enables them to save on the Suez Canal fees and also
make profit out of trading in oil in the midst of volatile prices.

·Some shipping companies are trying to kill
excess capacity to ensure that this supply disruption will impact prices
positively. For example, Maersk A/S, the world’s largest shipping company has
recently cancelled orders for 6 Triple-E class ships. Such cancellations may
become more common as shipping fleets will try to move towards supply
disruption.

·Shipping of freight is a highly commoditized
business and the scope for differentiation is quite limited. Hence some of the
larger shipping fleets are trying to diversify towards other higher margin
businesses like port terminal operations, marine maintenance services and
supply chain management.

·There is likely to be a major shakeout in the
shipping freight industry. Many large fleets have invested hugely in creating
economies of scale. Smaller and medium sized companies in this space may now
become acquisition targets as supply gets automatically streamlined and
rationalized. Normally, such tough times get to see synergistic alliances where
competitors tend to complement each other. For example, two of the largest
shipping companies, Maersk A/S and MSC have already formed alliances to share
routes and costs. Similarly, four of the largest Chinese have also formed a
national alliance to create virtual scale in the shipping industry to tide over
this situation.

Future lies in Uberization of Shipping Fleet:

We believe
that the future of the Shipping freight industry lies in a kind of Uberization.
Today the Shipping industry is vastly demarcated between the large fleet
carriers and the small & medium sized carriers. The small and medium
carriers are already finding it hard to survive in this tight freight market.
With the larger names forming formal and informal alliances, the effort will be
to squeeze out the small and mid-sized companies from the shipping freight
business. The major drawback in the global shipping freight industry is that
there is no scientific methodology for aggregating demand and supply and
matching them. Once this is done the entire shipping freight business can
become a lot more democratic and competitive. That is probably the best answer
to the woes of the shipping freight industry today.